Tuesday, October 5, 2010

In investing, nothing beats on-the-ground observations to get a better understanding of local culture.

In that regard, having visited many major cities in Asia as an equities fund manager, I am now travelling more to second and third tier cities in the region; to meet and talk to residents about the local economy, industries and companies.

I personally also find it more enjoyable and there is always interesting surprises.

I was in Ordos, Inner Mongolia in the middle of September, to meet up with some friends who are local businessmen in construction, property development and coal mining.

Ordos is special. It has gained international attention lately, often cited as a classic example of China’s property bubble or worst excesses – specifically, for building Kangbashi, a completely new administrative city about 25km from Dongsheng, the main city in Ordos County.

It is largely empty of people, and that’s why it’s called the “ghost city” of China.

Kangbashi was mostly completed in 2008 at an estimate cost of 17 billion yuan or US$2.5bil; it has ultra modern administrative buildings, museum, library and many middle to upper class homes (it is similar in a way to our Putrajaya – except bigger, a lot less people, with many very nice unoccupied houses).

Many of the houses and apartments in Kangbashi are sold, it is now ready for 300,000 residents (the original plan is for one million residents when fully completed in the future) but there is only about 28,000 people living there (as at April 2010 according to China Daily).

Ordos County is a rich mining area of about 1.6 million people. It is one of China’s major coal mining and natural gas producer (beneath Ordos is about 16% of China’s proven coal reserves and 33% of proven natural gas reserves).

2009 GDP per capita of Ordos (134,000 yuan or US$20,000) is higher than Shanghai (77,000 yuan or US$11,500) or Beijing (63,000 yuan or US$9,400) and quickly catching up to Hong Kong (US$29,900). There is clear evidence of wealth, for example, many of the cars on the streets in Dongsheng you see are new Mercedes, BMWs, Porsches and Range Rovers.

Which leads us to back to the “ghost city”, the Ordos county government built Kangbashi because frankly, it is rich enough to afford it. The development succeeded in enticing wealthy local residents to buy into the new Kangbashi suburbs, which boosted the construction sector and kept some of the wealth in local property investments.

Rich Ordos residents (and even local government officials) prefer to stay in the old Dongsheng city for now (I was told by some, until there is more facilities and people in Kangbashi. Seems logical.); hence many of the completed luxurious houses in Kangbashi remain unoccupied. Property owners I spoke to say they are not overly worried about servicing bank loans as they can afford it or has fully paid up. They are just not interested to move in yet.

I left Ordos with two property related thoughts.

One, I believe Kangbashi is a special case and certainly is not reflective of property markets in China; it is more akin to lavish spending (in a very big way) that you occasionally see in natural resource boom towns. I was told the central government is in fact asking the Ordos local government to slow down new developments in Kangbashi as they begin to curb pockets of excesses in certain cities and segments (especially speculative investments) of the property bubble in China.

Second, I do agree that property prices in certain Chinese cities and segments may seem high. In Beijing for example, local born Beijing residents mostly now buy properties outside the fourth ring road (about 8km from the centre) up to fifth (10km away) and sixth ring road (15km to 20km away).

Properties inside the fourth ring road are just not affordable. These are bought up by the rich from neighbouring provinces such by coal mining tycoons from Shaanxi, Shanxi and Inner Mongolia (no doubt from Ordos too).

According to a BCA report, the price-to-income ratio for 2010 in cities such as Shenzhen is about 25 years (in other words, the price of properties is equal to 25 years of household disposable income), for Beijing it is about 18 years and Shanghai is about 13 years.

However, average house price can be distorted, for example, by the much higher prices paid by rich tycoons of Shanxi for condominiums inside the fourth ring road of Beijing.

Similarly, household income may also be under reported. BCA research shows that since 1998, China’s urban household disposable income per capita has risen in line with the average rise in property prices. Therefore on average, people can still afford average houses.

My view is China will continue to be firm in curbing excessive speculation and price increases (the latest curb on 29 September include minimum 30% down payment for housing loans; and no bank lending for third and subsequent home purchase). I believe some of the more speculative locations are likely to consolidate, perhaps dropping as much as 20% to 30%.

Such price declines however, is not likely to cause a China banking crisis, nor will it likely affect economic growth. In fact, any slowdown in economic activities is likely to be offset by the government’s push to build more affordable public and private housing; with incentives such as tax exemptions for builders and owners of a segment of low income housing sector.

Interestingly, rising home price is a relatively new phenomenon in China. Compared to the many decades of booming house price in Japan (estimate from mid 1950’s until 1991), the “duration” of the current China property bubble is relatively short – private residential market in China only started to develop in 1998, and began to prosper around 2003.

With sharply rising property prices since mid 2009, China is acting early to try to bring stability to the housing market.

Having learned from past experiences (of Japan and US) about the dire consequences of a prolonged property bubble and excessive bank credit; China has been strengthening the balance sheet of banks, calling for more capital and restricting housing loans to curb speculations.

Having said all that, I also believe that any downward adjustment in prices may be temporary, China’s property prices is likely to climb for quite a few more years as the economy develops and urbanisation increases.

I leave you with this fact from Global Property Guide: Property prices (in US$ per square meter or psm) in Shanghai (US$6,000 psm) have yet to catch up with international metropolitans such as London (almost US$20,000 psm), New York (about US$16,000 psm), Moscow (about US$16,000 psm), Tokyo (about US$14,000 psm), Singapore (about US$13,000 psm) or even Mumbai (about US$12,000 psm).

Think about that.

The writer is the founder and chief investment officer of Singular Asset Management Sdn Bhd.

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